A financial domino theory that could make the last financial crash look appealing. Spiralling debt, rising unemployment and the lack of leadership are exacerbating an already unsteady situation. The markets are looking for clear political leadership and a robust message that they can rely on.

Europe in the last few weeks has become a worry. The Bond and currency markets smell blood. The continent has become a drag on the slow and fragile global recovery. The markets are murmuring that after Dubai failed to deliver a second recession, western Europe may well be the one to trigger the slide.

Could a Greek economic implosion contaminate first its European cousins and then the global markets and set everyone back two years? Yes, is the answer.

Clearly Greece is at the centre of everyone’s attention with some sort of a bailout package being expected any minute now. It is the catalyst that will either calm the markets’ nerves or unleash a genuine tragedy. People are convinced that the Germans are the only ones who have the clout and the money to come up with a solution. The Germans would prefer the bailout to be EU wide. It is a lot of money, over 50 billion euros is needed over half of which is needed in a matter of weeks. But the story does not stop with Greece.

Investors are looking at Europe and seeing a dramatic picture. They see mountains of debt, particularly in the UK, and the PIIGS, Portugal, Ireland, Italy, Greece and Spain. What would happen if suddenly confidence collapsed? Investors and financial researchers are even beginning to equate the Greek story with the UK one – indeed the figures are not so dissimilar. European markets are under terrific strain and are on a persistent downward trend. Are the rattling economies of Europe in danger of contaminating the US and Asian markets? Yes, hence the real worry. What was unthinkable three years ago is now touted as a near certainty.

There is a general feeling that three or four European countries are going to have to pay the price for their fiscal profligacy. Debt-driven expansion in Europe over the last twenty years has left a hefty bill to pay. That said, some European countries are struggling less than others, the Germans and the French are slightly more relaxed as their form of capitalism-lite and traditional fiscal responsibility has left them relatively unscathed by the recession. The PIIGS however, are struggling as their growth is faltering and they have massive accumulated debts to pay. Leadership is also lacking in Greece and Italy particularly, meaning that their reassuring words are falling on deaf ears.

Reduced tax receipts are hitting everyone hard but especially in Europe where unemployment is still rising, Spain is nearly hitting 20% and Italy is heading towards 9% (officially). The monthly payments on debt are putting an unsustainable burden on the various Treasuries. At a moment when Prime Ministers should be spending their way out of the doldrums they are being forced to make politically unpopular cuts. Political suicide.

The Greek story may have a solution. It may after all be the IMF that comes to the rescue of Greece. If this should happen, it would be a humiliating slap in the face for the EU, demonstrating that it was not able to keep its house in order, solve serious problems or even reach a collective decision when the chips were down. This is an eventuality the EU Commission will be studiously avoiding.

Be that as it may, the question remains: will there be a domino effect, with bond and currency markets triggering a self fulfilling prophesy by putting Spain, Italy, Estonia and Lithuania under their merciless microscope and deducing that they are dead ducks? There are already rumours of hedge funds ganging up on the Euro to “short” it to death. The smart money is saying that Europe is heading for a mini Armageddon.

Some sort of a credible response is needed to head the heartless traders off at the pass but the timing could not be worse. Now that the various stimulus packages are beginning to be wound down, the next step will have to be the imposing of monetary restraint. This inevitably will mean a tightening of monetary policy, which will cause yet further pain for Europeans. Liquidity will be drying up, inflation rising and governments will be cutting every social programme in sight. The unemployed will be taking to the streets shoulder to shoulder with the disgruntled taxpayer.

The markets are waiting for a signal and not necessarily a financial one. They are looking for clear political leadership and a robust message that they can rely on. The political disarray in the EU is clearly not conducive to the formulation of such a message. The markets need a credible story so they can direct their attention elsewhere. Every day that goes by without a robust rebuttal, the more the markets convince themselves of the inevitable.

This time, the fiction of political unity may have to come from the European Central Bank and not the EU Commission. Time, however, is not on Europe’s side.